Not Enough Tears Yet

As we have seen the market sell off for two of the past few trading days, I've started to get the questions, calls and emails wondering if this is a buying opportunity. It seems we have gotten so used to the stock market going up that market players think of every little selloff as a chance to buy. During the week, I have covered the fact that I believe material and energy names have seen enough sustained selling that they are bargain issues worth accumulating. Many of these have lost more than 50% over the past year, and they have become falling knives worth catching, in my opinion.

But the stock market, as measured by the S&P 500, is barely 4% off the 2013 and all-time highs. The Dow Joes Industrial Average is about 2% off its own peak, and the Nasdaq Composite is about 3% down from its highs. While it can always get worse, this is really just a hiccup along the journey so far. It is not yet time to break out the canes and hobble down to Wall Street. There are certainly no tears yet.

Let's inject some reality into the situation. The markets up are around 15% or so far for 2013. The zero-interest-rate policy adopted by the Federal Reserve continues to trump all corporate and economic news, and the stock market has shrugged off news that would have sent it into a tailspin back in the earlier part of the century. 436 of the stocks in the S&P 500 are up on the year. 28 of the 30 Dow components are in positive territory as well. Only Alcoa (AA) and Caterpillar (CAT) are down on the year.

There is no fire sale going on, either, based on valuations we're seeing in the stock market. Only 45 stocks in the S&P 500 sell for less than stated book value, and far fewer than that for less than tangible book value. Only 38 sell for single-digit price-to-earnings ratios right now. By comparison, 199 of the stocks in the index sell for more than 20x earnings. Three of the Dow 30 sell for less than book value, and only six have a single-digit earnings multiple. It is not a ridiculously priced market, but neither is it particularly cheap, in spite of a little downside volatility this week.

We are not seeing a plethora of bargains out in the broader market, either. My regular value screens continue to show small returns, as the rally has lifted most stocks out of too-cheap-not-to-own status. When I run a screen of stocks based on the criteria of Walter Schloss, I find just 22 that trade below book value, have decent levels of insider ownership and strong balance sheets with market capitalization above $100 million. There are only 40 more with a market cap above $10 million. If we conduct a search for perfect stocks that trade below book value, are profitable and pay dividends, we find just 51 that qualify. In the case of both screens, most of the stocks are in the materials, energy or small-bank sectors. Quite simply, there are not a lot of cheap stocks right now.

Compare that with the summer of 2011, the last time we saw an S&P selloff of close to 20% -- from 1340 to about 1120. Goldman Sachs (GS) was below $100 a share, and Bank of America (BAC) was under $5. Plenty of shipping centers and hotel real estate investment trusts were selling below book value. Cisco Systems (CSCO) was trading as low as $15 as investors fled the stock market. I was buying regional banks like KeyCorp (KEY) and Huntington Bancorp (HBAN) well below tangible book value at the time. Micron Technology (MU) sold at around $5 a share after it had tumbled with the market. There were plenty of bargains, and it was easy to find and buy cheap stocks.

Consider a period when we had a real bargain opportunity -- like what we saw in 2008 and 2003. Get out your old chart books and look at the market in those years. That's what a buying opportunity looks like. We witness panic, disgust and widespread margin calls. Blue-chips sell for single-digits and second-tier companies sell for less than the cash on the books. Screens return hundreds of quality issues below book value, and the hard part is selecting the one to buy. Brokers and investment banks go out of business, and commentators are depressed and confused. That's a buying opportunity.

So far, this has been a minor dip. It may become more than, and I hope it does, as I have decent cash balances right now. You can start to scale in, buying the material sand energy stocks -- but, beyond that, nothing of note is happening in the broader market that should catch the attention of a long-term value investor.

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